Non-Performing Loans: CBN Directs Banks to Strengthen Buffers

Concerned about the level of loan loss reserves being reported by commercial banks, the Central Bank of Nigeria (CBN) in a proactive measure has mandated the Nigerian lenders to immediately double their general provisions on performing loans to two per cent, from one per cent previously.

This new policy became effective this week.

Lagos-based financial advisory and research firm, Renaissance Capital (RenCap. Analysts commended the apex bank for taking the initiative as a result of the headwinds on the economy as well as the deterioration in the macro-economy.

“As we share similar concerns on the adequacy of provisions, given the notable deterioration in the macro environment, we view this as positive. On the other hand, we also see it as having some negative implications for dividend payouts and capital ratios,” Renaissance Capital stated.

Nigerian banks report provisioning according to International Financial Reporting Standards (IFRS), but this is also cross-checked against the CBN’s prudential provisioning requirements.

In light of this, general provisioning, according to RenCap, does not apply under IFRS but applies under the CBN prudential provisioning requirements.

“Where the CBN provisions exceed IFRS required provisions, the excess is reported as a non-distributable regulatory risk reserve (RRR) under equity, but is excluded from the computation of regulatory capital in the determination of capital adequacy ratios (CAR). Collective impairments on loans, receivables and other financial assets are also excluded by the CBN from being included in the determination of tier 2 capital.

“Therefore, doubling the general provisioning to two per cent increases the likelihood of the RRR exceeding IFRS provisions, presenting downside risks to dividend payouts and CAR. It is important to state explicitly that a doubling of the general provisioning requirements has no implication on profit and loss financial statements, but on equity, capital adequacy and distributable retained earnings for dividends,” they added.

However, from a capital adequacy view point, in its opinion, RenCap noted that the regulation would potentially put the most strain on the CAR of FBN Holdings, Skye Bank and Ecobank Nigeria.

“As at nine month ended 2015, these banks reported CAR of 16.2 per cent, 17.3 per cent and 16.9 per cent respectively, versus their current 15 per cent regulatory minimum requirement and the 16 per cent minimum requirement for systemically important banks (SIB).

“The higher CAR for SIBs takes effect from 1 July 2016. We see another potential capital stress point for the Nigerian banks in the CBN’s updated capital computation template, which is yet to take effect but has tighter restrictions on credit mitigants and risk weights. While we still expect these banks to approach the market for capital, should they struggle to execute a successful raise, we think the CBN would be lenient, given the testing market environment,” RenCap noted.

Owing to banks’ exposure to the oil and gas sector in the face of tumbling oil prices as well as the risk management deficiencies revealed by a recent risk-based supervision exercise it had conducted, the CBN had last year directed commercial banks to ensure that they have sufficient capital buffers to mitigate the escalating risk-taking activities.
“Consequently, the central bank had stated that where exposure to the oil and gas sector (as defined by the International Standard Industrial Classification of Economic Sectors as Issued by the CBN), is in excess of 20 per cent of total credit facilities of a bank, the risk weight of the entire portfolio in such facilities would attract a risk weight of 125 per cent for the purpose of capital adequacy computation.

In addition, banks were directed to prepare and forward to the central bank their computation and results of their single-factor sensitivity stress test. -Thisday

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